When the Gift of a Security Can Become an Insider Trading Charge

When is a gift of securities not really a gift?

According to the Securities and Exchange Commission, it’s when the donor knows or should know that the recipient is going to sell the securities soon after receiving them.

Under these circumstances, the SEC says it’s as if the donor is selling the securities and then gifting cash proceeds.

If this happens at a time when the donor is aware of material nonpublic information, the donor could be subject to insider trading liability. The SEC indicated this in December when it adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934.

The SEC also imposed new disclosure requirements regarding trading plans under Rule 10b5-1, insider trading policies, and timing of option grants.

It is imperative for companies to assess their policies and practices to ensure compliance with the SEC changes.

The statutory basis for insider trading liability under federal law can be found in Section 10(b) of the Exchange Act and Rule 10b-5, which broadly prohibit the use of manipulative or deceptive devices “in connection with the purchase or sale of any security.”

Amendments to Rule 10b5-1

Rule 10b5-1 enables a public company’s insiders to purchase or sell the company’s securities while in possession of material nonpublic information. However, this must be done under a plan adopted before they became aware of the information.

The SEC made two important changes to this rule.

First, anyone setting up a Rule 10b5-1 plan, other than an issuer using one for stock repurchases, will have to endure a cooling-off period. This will range from 30 to 120 days before the first transaction may occur.

Second, persons other than issuers will be limited in their ability to have more than one Rule 10b5-1 plan in effect at the same time and more than one single-trade Rule 10b5-1 plan during any consecutive 12-month period.

These changes will take effect on Feb. 27.

Liability for Gifts

Before the SEC’s recent pronouncement on insider trading liability for gifts, it was an open question whether liability existed.

Some practitioners took the position that because a gift is neither a purchase nor a sale, an insider could gift securities at any time—even when aware of material nonpublic information—without incurring insider trading liability. This position is clearly at odds with the SEC’s recently stated position.

The SEC has now clarified that a Rule 10b5-1 plan may be used for gifts of securities. This includes a gift that might otherwise subject the donor to insider trading liability because at the time of the gift the donor had material nonpublic information and knew―or should have known―that the recipient would sell the securities before that information was publicly disclosed.

New Reporting Deadline

For a company’s officers or directors subject to Section 16 of the Exchange Act, using a Rule 10b5-1 plan might not hold the same appeal it once did because of the new cooling-off period requirement.

A director’s or officer’s first transaction may not occur until the later of 90 days after adoption of the plan or two business days after the filing of a company’s financial statements covering the quarter in which the plan was adopted. The maximum required cooling-off period is 120 days after the plan adoption date.

The SEC also changed the way gifts must be reported by people subject to Section 16. This includes directors, officers, and shareholders who own more than 10% of any class of the company’s equity securities registered under the Exchange Act.

Currently, gifts of securities for those subject to Section 16 do not need to be reported until 45 days after the end of a company’s fiscal year. Starting April 1, 2023, such gifts must be reported within two business days, the same deadline that applies to most other reportable transactions.

What to Do Now

Companies should review their insider trading policies to determine whether gifts of securities are adequately addressed.

The safest approach, based on the SEC’s recently stated position, is to treat gifts the same as sales if the donor knows or has reason to believe that the recipient will likely sell the securities soon after receiving them.

This is typically the case with gifts of securities to charitable organizations, but could also apply to other gifts of securities.

Any such gifts should be limited to quarterly trading windows unless a Rule 10b5-1 plan is used. This will likely require insiders to plan their gifts of securities months in advance, rather than waiting until the end of the year to make them.

Companies should also ensure that their directors and officers are aware of the new accelerated reporting requirements for gifts of securities that will soon take effect.

The insider trading laws are complex and contain numerous traps for the unwary, and proper planning is necessary to avoid these pitfalls.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Craig M. Scheer is a partner at Silver, Freedman, Taff & Tiernan where he counsels clients on a wide range of corporate and securities legal matters, including public and private securities offerings, SEC reporting compliance, and insider trading compliance.